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Written by Michael Mauboussin, Head of Consilient Research at Counterpoint Global and previously Head of Global Financial Strategies at Credit Suisse, The Success Equation (as its subtitle suggests) is about the disentanglement between skill and luck so we can avoid biases and make better decisions.

There was a section in Think Twice (read my summary here) that discusses this skill-luck concept briefly, and I was intrigued. Which was the reason why I picked up this book.

Here are my notes from The Success Equation.

Untangling skill and luck

• Luck is a chance occurrence that affects a person or a group. Luck can be good or bad. Furthermore, if it is reasonable to assume that another outcome was possible, then a certain amount of luck is involved. In this sense, luck is out of one’s control and unpredictable.
• Introducing a little bit of luck into a system can make the level of genuine skill very difficult to measure.
• Randomness and luck are related, but there is a useful distinction between the two. You can think of randomness as operating at the level of a system and luck operating at the level of the individual.
• The consequences of our efforts, both good and bad, reflect an element within our control—skill—and an element outside of our control—luck. In this sense, luck is a residual: it’s what is left over after you’ve subtracted skill from an outcome.
• Realising good or bad luck says nothing about you as a person. If you’ve benefited from good luck, be happy about it and prepare for the day when your luck runs out. And don’t feel affronted when you suffer from bad luck. Provided that you have approached the activity in the correct fashion, you want to shrug off the poor results and go about your business in the same fashion in the future.
• So here’s the distinction between activities in which luck plays a small role and activities in which lucks plays a large role: when luck has little influence, a good process will always have a good outcome. When a measure of luck is involved, a good process will a good outcome but only over time.
• When skill exerts the greater influence, cause and effect are intimately connected. When luck exerts the greater influence, cause and effect are only loosely linked in the short run.
• There’s a quick and easy way to test whether an activity involves skill: ask whether you can lose on purpose.
• In considering skill, it is also important to distinguish between experience and expertise. There is an unspoken assumption that someone doing something for a long time is an expert. In activities that depend largely on skill, though, expertise comes only through deliberate practice, and very few individuals are willing to commit the time and effort to go beyond a plateau of performance that’s good enough.
• The confusion between experience and expertise is particularly acute in fields that are complex and where luck plays a big role. One of the signatures of expertise is an ability to make accurate predictions: an expert’s model effectively ties cause to effect. By this measure, experts who deal with complex systems fare poorly.

Why we’re bad at separating skill and luck

• Our minds have an amazing ability to create a narrative that explains the world around us, an ability that works particularly well when we already know the answer. There are a couple of essential ingredients in this ability: our love of stories and our need to connect cause and effect.
• If we look into the past, skill and luck appear to be inextricably fixed, even though the history that we lived through was but one of many possible histories that could have occurred. While we are capable of contemplating a future pulsating with possibility, we quickly forget that our experience was one of many that could have been. As a consequence, we often draw lessons from the past that are wrong.
• The blend of those two ingredients leads us to believe that the past was inevitable and to underestimate what else might have happened.
• To explain the past, we also naturally apply the essential elements of stories: a beginning, an end and a cause. As events in our world unfold, we don’t—really, can’t—know what’s happening. But once we know the ending, we stand ready to create a narrative to explain how and why events unfolded as they did.
• Even if we acknowledge ahead of time that an event will combine skill and luck in some measure, once we know how things turned out, we have a tendency to forget about luck. We string together the events into a satisfying narrative, including a clear sense of cause and effect, and we start to believe that what happened was preordained by the existence of our own skill.

The luck-skill continuum

• When skill dominates, a small sample is sufficient to understand what’s going on.
• In activities that are strongly influenced by luck, a small sample is useless and even dangerous. You’ll need a large sample to draw any reasonable conclusion about what’s going to happen next.
• We’re naturally inclined to believe that a small sample is representative of a larger sample. In other words, we expect to see what we’ve already seen. This fallacy can run in two directions. In one direction, we observe a small sample and believe, falsely, that we know what all of the possibilities look like.
• In many situations we have only our observations and simply don’t know what’s possible. To put it in statistical terms, we don’t know what the whole distribution looks like. The greater the influence luck has on an activity, the greater our risk of using induction to draw false conclusions.
• The paradox of skill: as skill improves, performance becomes more consistent, and therefore luck becomes more important.

How to build skill

• Klein and Kahneman agreed that expertise is valid under relatively narrow conditions: you can become an expert if cause and effect are clear and consistent in what you do and if you practice intensely and are guided by accurate feedback.
• For activities that take place in environments that are stable and in which luck plays a small role, deliberate practice improves skill. Under those conditions, people can develop true expertise.
• When activities are more influenced by luck, you won’t get that kind of feedback, at least in the short term. What you do is not connected strongly to the result. So the best approach is to focus on the process you’re using.
• Most jobs have elements that combine tasks that are familiar with those that are unfamiliar. In those situations, checklists can help a lot in improving your skill.
• “Systems 1 and 2 are both active whenever you are awake. System 1 runs automatically and System 2 is normally in a comfortable low-effort mode, in which only a fraction of its capacity is engaged. System 1 continuously generates suggestions for System 2: impressions, intuitions, intentions and feelings. If endorsed by System 2, impressions and intuitions turn into beliefs, and impulses turn into voluntary actions. When all goes smoothly, which is most of the time, System 2 adopts the suggestions of System 1 with little or no modification. You generally believe your impressions and act on your desires, and that is fine — usually.”
• “Systems 1 and 2 are both active whenever you are awake. System 1 runs automatically and System 2 is normally in a comfortable low-effort mode, in which only a fraction of its capacity is engaged. System 1 continuously generates suggestions for System 2: impressions, intuitions, intentions and feelings. If endorsed by System 2, impressions and intuitions turn into beliefs, and impulses turn into voluntary actions. When all goes smoothly, which is most of the time, System 2 adopts the suggestions of System 1 with little or no modification. You generally believe your impressions and act on your desires, and that is fine — usually.”
• Here’s what deliberate practice comes in. You can become an expert by using deliberate practice to train your System 1. You become an expert when you learn to perform unconsciously and free your attention for higher-level thinking.
• Deliberate practice and the concept of expertise apply only near the skill side of the luck-skill continuum. You can train System 1 only for activities that are stable and linear.
• When your undertaking involves a dose of luck, the link between cause and effect is broken. In the short term, even when you do everything right, the outcome of your effort can be bad.

How to deal with luck

• When competing one-on-one, follow two simple rules: if you are the favourite, simplify the game. If you are the underdog, make it more complicated.
• In a Colonel Blotto game with three battlefields, a player with 25% more soldiers will win 60% of the battles. A player with an army twice as large as his opponent’s will win 78% of the time. While luck still exerts an influence, the bigger army has a decisive advantage. This analysis is what lies behind the first rule. If you are the stronger player, simplify the game and go toe-to-toe. The larger your army, the more likely you are to win.
• If the two armies are the same size, then adding battlefields doesn’t change how many times each side wins. But when one player has more soldiers than the other, the stronger player’s advantage goes down as the number of battlefields goes up. For example, in a game with 15 battlefields, the weaker player’s chance of winning is nearly 3x higher than it is in a game with nine.
• In his book How the Weak Win Wars, Ivan Arreguin-Toft analyzed rougly two hundred wars that took place between weak and strong opponents between 1800 to 203. He called those wars asymmetric conflicts. He considered a war asymmetric if the stronger nation’s resources—the size of its armed forces and population—exceeded those of the weaker country by a factor of ten or more. Surprisingly, the stronger country prevailed just 72% of the time. Since this analysis included only wars where the asymmetry in resources was large, the success of the weaker players is even more remarkable.
• Nearly 80% of the losers in asymmetric wars never switch strategies. Part of the reason combatants don’t switch is that when training and equipment are developed for one strategy, it’s often costly to shift to another. Leaders or organisational traditions also stand in the way of adopting new strategies. This type of inertia often prevents an organisation from pursuing the strategy that offers the best chance of winning.

Reversion to the mean

• The important point is that expected rate of reversion to the mean is a function of the relative contributions of skill and luck to a particular event. If what happens is mostly the result of skill, then reversion toward the mean is scant and slow.
• If the outcome is mostly due to luck, reversion to the mean will be pronounced and quick.
• Specifically, reversion to the mean creates three illusions. The first is the illusion of cause and effect. Our natural inclination is to look for what is causing a given measurement to regress toward the mean, an exercise that is frequently fruitless.
• There is also the illusion of feedback, which makes it seem like favourable feedback leads to worse results and unfavourable feedback leads to better results.
• Finally, there’s the illusion of declining variance, the idea that reversion to the mean implies that everything we can measure converges on the same average value over time.

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